Strong, Volatile Kiwi Worries The Treasury

Monday 6th July 2009

The strength of the New Zealand dollar is starting to worry The Treasury, which clearly nominates currency strength as one of the big potential spoilers both for economic recovery by the end of this year and for a sustained reduction in the current account deficit.

"With world growth weak, the risk is that exports do not rise as expected, frustrating the projected recovery in growth," the Treasury says. Under those circumstances, the ratio of the current account deficit to GDP would be unlikely to improve beyond 7%.

This is a significant change from Budget forecasts issued on May 28, which showed the current account falling to 6.9% of GDP in 2009 and then sustainably to around 5.5% from 2010 to 2012. New Zealand's high current account deficit is regarded as the country's economic Achilles heel, being substantially higher than the OECD average.

"Substantial headwinds in the form of a rising currency, rises in oil prices and in international interest rates caution against expectations of a larger gain (than 7%). In addition, the import-driven nature of the reduction raises questions about the sustainability of the contraction in the deficit.

"A recovery in domestic demand will likely see imports recover and, unless export earnings rise, the current account deficit will widen again."

The current account deficit is currently at 8.5% of GDP and falling, thanks largely to much reduced imports. New Zealand's monthly trade balance has recently started running in strong surplus, reflecting the collapse in domestic demand from the third quarter of 2008, which has more than offset reduced demand and prices for New Zealand exports.

The Treasury's monthly economic indicators report, issued today, also notes recent media coverage on the "unusually large volume of New Zealand dollar denominated bonds (Uridashi and Eurokiwi) maturing over July as likely to push the New Zealand currency down".

"How strong this effect will be remains to be seen. Reserve Bank research suggests that any effect on the currency at the time of maturity tends to be small, priced in by forward currency markets. Nonetheless, early indications are the currency is likely to experience a rise in volatility," the Treasury says.

Businesswire.co.nz

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